7 Tricks to Use When Refinancing a Mortgage

Refinancing can be a very effective way to save money -- just be sure to go about the process in an informed manner, making sound choices along the way. These seven tips can help.

Interest rates are starting to inch up, with many expecting the Fed to raise rates a little more later this month. A recent strong jobs report is only making that more likely. If you have thought about refinancing your mortgage, you might want to think hard about it now, and perhaps lock in a low rate if you're serious.

Refinancing is taking on a new home loan to pay off your old home loan. The new mortgage can have different features, such as a longer or shorter term, and it can lower your monthly payments, too.

Beef up your credit score

Before you start talking with lenders about refinancing your mortgage, make sure your credit score is strong -- and if it's not, spend some time looking into how you might raise your score, such as by correcting errors in your credit report, paying down debt, and paying bills on time. The table below shows what kind of difference a strong score can make. It reflects recent interest rates for someone borrowing $200,000 via a 30-year fixed-rate mortgage and makes clear how much you might save by boosting your score.

FICO Score

APR

Monthly Payment

Total Interest Paid

760-850

4.022%

$957

$144,653

700-759

4.244%

$983

$153,944

680-699

4.421%

$1,004

$161,442

660-679

4.635%

$1,029

$170,611

640-659

5.065%

$1,082

$189,377

620-639

5.611%

$1,105

$213,836

SOURCE: MYFICO.COM, AS OF MID-MARCH 2017.

Compare APRs, not APYs

When shopping around and comparing mortgage interest rates, be sure to pay more attention to quoted annual percentage rates (APRs) than annual percentage yields (APYs). The APY will indeed reflect a loan's interest rate, but the APR will more accurately reflect what you'll be paying -- because it incorporates expenses such as closing costs.

Pick the right length

When considering what kind of new mortgage to take on to replace your old one, think about how long you want your mortgage to last. Most people take on 30-year loans, and most people know about 15-year loans, which generally feature significantly higher payments and lower rates -- but know that those are not the only options. There are 20-year mortgages, too, which offer a nice compromise between the 15- and 30-year loans. And there are even 40-year mortgages, as well as other lengths. Your best bet is to figure out how much you can comfortably afford in monthly mortgage payments and then get the shortest-term loan that matches up with that.

Pay more

As you go through the process of getting pre-approved and approved for your new loan, make sure it won't penalize you for making prepayments against your principal. Why? Well, because you can save gobs of money by paying more than you have to each month -- or each quarter, each year, or just occasionally. The table below shows just how much someone might save by making various kinds of monthly prepayments. It assumes a 30-year $200,000 fixed-rate mortgage taken out at an interest rate of 4.5%. The regular monthly payment would be $1,013.38.

Payment Method

Pay Off Loan In...

Total Interest Paid

Total Interest Saved

Minimum payment

30 years

$164,810

$0

$100 extra monthly

25 years

$133,066

$31,744

$200 extra monthly

21 years and 6 months

$112,056

$52,753

$500 extra monthly

15 years and 3 months

$76,698

$88,111

$1,000 extra monthly

10 years and 5 months

$50,679

$114,131

SOURCE: AUTHOR CALCULATIONS AT MTGPROFESSOR.COM.

Don't fall for "no-cost" refinancings

There are always costs. Refinancings, like original mortgages, have closing costs -- and you'll either pay them upfront or they'll be conveniently tacked onto your loan amount -- which can increase your interest rate. It's usually best to pay the costs upfront. (If you're not planning to stay in the home long, though, it can be worth folding the closing costs into the loan, as you won't be dealing with the higher interest rate for too long.)

Consider paying "points"

You may be able to lower your interest rate (and thus the amount you'll pay in interest over the life of the loan) by paying "points." A point is equal to one percentage of your loan value. So if you're borrowing $200,000, a point would be $2,000. You can often reduce your loan's interest rate by about 0.25% or so per point paid. This can be well worth it -- as long as you expect to be in the home long enough to break even. If you're saving $40 per month by paying a $2,000 point, dividend $2,000 by $40 and you'll get 50, meaning that it will take 50 months before you break even.

Don't take cash out

Many people refinance to cash out some of their home equity, but it's generally best not to do so. As an example, imagine that your home is worth about $300,000. If you currently owe $150,000 on it and have $150,000 in home equity, you might refinance into a new $200,000 loan, keeping about $50,000 in cash. The cash is nice -- and with current low interest rates it's an inexpensive way to borrow money -- but you've now set yourself up with a bigger mortgage and you have less home equity. Think carefully about whether it's worth it. If you're going to use the cash to pay off high-interest rate credit card debt, for example, that's a smart money move. Know, too, that cash-out refinancings can carry higher interest rates than ones without cash-outs.

Refinancing can be a very effective way to save money -- just be sure to go about the process in an informed manner, making sound choices along the way.